MOSCOW BLOG: OPEC hints at more production cuts as Russia deepens ties in Middle East

Russian president Vladimir Putin with King of Saudi Arabia Salman bin Abdulaziz al-Saud at the G20 in 2015

By Ben Aris in BerlinOctober 20, 2017

The oil cartel OPEC is hinting that it will extend the oil production cuts that have successfully driven up the price of a barrel of crude into the $50s, at its next meeting in Vienna, according to a report from Reuters citing four unnamed OPEC sources.

The success of the production deal in pushing up prices is partly due to Russia’s agreement to participate in the scheme that has been dubbed OPEC+ as Russia is not formally part of the cartel. More important than Russia’s stated support is the fact that it has complied with its commitment to cut 300,000 barrels of production off its daily quota, despite wingeing from its major oil companies.

This decision has brought economic benefits as the Russian budget functions at $50 per barrel and over, although it continues to run a modest federal budget deficit. The Russian budget doesn't function at $40 per barrel as was shown with the problems the Ministry of Finance faced in 2016, because the Russian state cannot fund the budget deficit from domestic sources alone.

The Russian budget currently breaks even at about $70 per barrel, but under the new budget being considered by the Duma this month that is planned to fall to $42 by 2020. The Ministry of Finance’s task has been made a lot easier by the freeing of the ruble exchange rate in 2014 as devaluation of the currency has absorbed some of the shock of falling oil prices and reduced the state’s funding needs; indeed, as budget spending is priced in rubles but around a third of its revenues are denominated in dollars, the state itself is one of the biggest winners from the devaluation of the ruble. The same is not true for Saudi Arabia that has a budget break even price for oil of around $80, according to bne IntelliNews columnist Chris Weafer. And the kingdom has maintained a peg to the dollar that means it has been bleeding cash to maintain the exchange rate.

The OPEC+ deal has also brought Russia significant political benefits that could prove to be transformational. Russia had already seen its influence in the Middle East rise dramatically following its successful support for President Bashar al-Assad in they Syrian war, which appears to reaching its end game. Russia was strong in the Middle East during Soviet times (it was an early investor into Iraq’s oil fields) and has successfully reactivated many of those ties, partly thanks to the failure of US foreign policy in the region.

In particular, Russia has made rapid process in moving closer to Riyadh, highlighted by the recent visit to Moscow by Saudi Arabia’s King Salman bin Abdulaziz Al Saud.

The oil production cut deal paved the way, but on the table now are arms deals and Russia’s ability to play middle-man in the various disputes in the region. The Saudis are grateful for President Vladimir Putin’s support, and more importantly Russia’s friendship doesn't come with pesky criticisms of human rights abuses. But the overwhelming factor in Saudi’s move towards Moscow is its fury over the US decision to ignore its interests and push ahead with its own shale oil production that has cut the price of oil in half after the US added some 10mn of barrels a day to global production in less than a decade. Pointedly, the US is not participating in the production cut deal.

The headless leadership in the White House has created an opening for Russia in the Middle East which the Kremlin has gleefully stepped into. However, the reactivation of traditional Soviet ties is only part of Russia’s overreaching foreign policy to break the US’s hegemony over global geopolitics and create a “multipolar” world that is led by international bodies like the G20 and the United Nations (UN). Moscow has already successfully brought China on board with this policy, as Beijing has similar complaints about Washington’s meddling in domestic issues and the two countries are now in a rapidly developing military-economic alliance that clearly is not in Washington’s interests.

But beyond the Sino-Russian alliance, the US and Europe’s attempts to isolate Russia on the global stage have spectacularly backfired as New Delhi and Brasilia have also rallied to the Russian flag, along with many other countries, including several traditional friends in the EU. Rather than isolating Russia, the Kremlin has benefited from fast deepening political and economic ties with emerging markets, which in the meantime represent the larger part of both the world’s population and its wealth. At some point it is the west that is going to start looking isolated.

The OPEC+ partners were originally hoping to bring down the price of oil to a point where it becomes unprofitable to extract shale oil (originally assumed to be around the $70 per barrel mark, but thanks to technology advances probably closer to the $40 mark now). However, this strategy seems to have failed.

In order to boost revenues the OPEC sources said the cartel is leaning towards extending the deal with Russia and other non-members to cut oil supply for a further nine months, although stronger-than-expected demand growth may allow the group to delay a decision until early next year.

All-in-all the OPEC+ participants have agreed to cut production by about 1.8mn barrels per day until March 2018, in an attempt to eradicate the current glut in supply. OPEC is due to hold its key annual meeting in Vienna on November 30 when it traditionally sets production targets for members, but this year’s meeting will be especially important. Three OPEC sources said keeping the curbs in place until the end of 2018 was the likely outcome of the meeting. The fourth source told Reuters that an extension of six to nine months would be needed to remove all excess oil in storage.

Before then, OPEC’s board of governors, who do not decide policy, will meet in Vienna on October 23-24 and are likely informally to discuss options and scenarios, OPEC sources said. Putin said on October 4 the deal could be extended to the end of 2018.

If no decision is reached in Vienna there is another meeting scheduled for May or June.

OPEC wants to reduce the level of oil stocks in developed economies to the five-year average. Currently these stocks are 2.996bn barrels, or 171mn barrels above the five-year average, down from a peak in January of 340mn barrels.

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